26
C.F.R. § 1.897-1
§ 1.897-1 Taxation of foreign investment in United States real property interests, definition of terms.
(a) In general--(1) Purpose and scope of
regulations. These regulations provide guidance with respect to the
taxation of foreign investments in U.S. real property interests and related
matters. This section defines various terms for purposes of sections 897,
1445, and 6039C and the regulations thereunder. Section 1.897-2 provides
rules regarding the definition of, and consequences of, U.S. real property
holding corporation status. Section 1.897- 3 sets forth rules pursuant to
which certain foreign corporations may elect under section 897(i) to be treated
as domestic corporations for purposes of sections 897 and 6039C. Finally,
§ 1.987-4 provides rules concerning the similar election under section 897(k)
for certain foreign corporations in the process of liquidation.
(2) Effective date. The regulations set forth in
§§ 1.897-1 through 1.897-4 are effective for transactions occurring after June
18, 1980. However, with respect to all transactions occurring after June
18, 1980 and before January 30, 1985, taxpayers may at their option choose to
apply the Temporary Regulations under section 897 (in their entirety). The
Temporary Regulations are located at 26 CFR §§ 6a.897-1 through 6a.897-4
(Revised as of April 1, 1983), and were originally published in the Federal
Register for September 21, 1982 (47 FR 41532) and amended by T.D. 7890,
published in the Federal Register on April 28, 1983 (48 FR 19163).
(b) Real property--(1) In general. The term
"real property" includes the following three categories of
property: Land and unserved natural products of the land, improvements,
and personal property associated with the use of real property. The three
categories of real property are defined in subparagraphs (2), (3), and (4) of
this paragraph (b). Local law definitions will not be controlling for
purposes of determining the meaning of the term "real property" as it
is used in sections 897, 1445, and 6039C and the regulations thereunder.
(2) Land and unserved natural products of the
land. The term "real property" includes land, growing crops and
timber, and mines, wells, and other natural deposits. Crops and timber
cease to be real property at the time that they are served from the land.
Ores, minerals, and other natural deposits cease to be real property when they
are extracted from the ground. The storage of severed or extracted crops,
timber, or minerals in or upon real property will not cause such property to be
recharacterized as real property.
(3) Improvements--(i) In general. The term
"real property" includes improvements on land. An improvement
is a building, any other inherently permanent structure, or the structural components
of either, as defined in subdivisions (ii) through (iv) of this paragraph
(b)(3).
(ii) Building. The term "building"
generally means any structure or edifice enclosing a space within its walls,
and usually covered by a roof, the purpose of which is, for example, to provide
shelter or housing or to provide working, office, parking, display, or sales
space. The term includes, for example, structures such as apartment
houses, factory and office buildings, warehouses, barns, garages, railway or
bus stations, and stores. Any structure that is classified as a building
for purposes of section 48(a)(1)(B) and § 1.48-1 shall be treated as such for
purposes of this section.
(iii) Inherently permanent structure--(A) In
general. The term "inherently permanent structure" means any
property not otherwise described in this paragraph (b)(3) that is affixed to
real property and that will ordinarily remain affixed for an indefinite period
of time. Property that is not classified as a building for purposes of
section 48(a)(1)(B) and § 1.48-1 may nevertheless constitute an inherently
permanent structure. For purposes of this section, affixation to real
property may be accomplished by weight alone.
(B) Use of precedents under section 48. Any
property not otherwise described in this paragraph (b)(3) that constitutes
"other tangible property" under the principles of section 48(a)(1)(B)
and § 1.48-1(c) and (d) shall be treated for purposes of this section as an
inherently permanent structure. Thus, for example, the term includes
swimming pools, paved parking areas and other pavements, special foundations
for heavy equipment, wharves and docks, bridges, fences, inherently permanent
advertising displays, inherently permanent outdoor lighting facilities,
railroad tracks and signals, telephone poles, permanently installed telephone
and television cables, broadcasting towers, oil derricks, oil and gas
pipelines, oil and gas storage tanks, grain storage bins, and silos.
However, property that is determined to be either property in the nature of
machinery under § 1.48-1(c) or property which is essentially an item of
machinery or equipment under § 1.48-1(e)(1)(i) shall not be treated as an
inherently permanent structure.
(C) Absence of precedents under section 48.
Where precedents developed under the principles of section 48 fail to provide
adequate guidance with respect to the classification of particular property,
the determination of whether such property constitutes an inherently permanent
structure shall be made in view of all the facts and circumstances. In
particular, the following factors must be taken into account:
(1) The manner in which the property is affixed to
real property;
(2) Whether the property was designed to be easily
removable or to remain in place indefinitely;
(3) Whether the property has been moved since its
initial installation;
(4) Any circumstances that suggest the expected period
of affixation (e.g., a lease that requires removal of the property upon its
expiration);
(5) The amount of damage that removal of the property
would cause to the property itself or to the real property to which it is
affixed; and
(6) The extent of the effort that would be required to
remove the property, in terms of time and expense.
(iv) Structural components of buildings and other
inherently permanent structures. Structural components of buildings and
other inherently permanent structures, as defined in § 1.48-1(e)(2), themselves
constitute improvements. Structural components include walls, partitions,
floors, ceilings, windows, doors, wiring, plumbing, central heating and central
air conditioning systems, lighting fixtures, pipes, ducts, elevators,
escalators, sprinkler systems, fire escapes and other components relating to
the operation or maintenance of a building. However, the term
"structural components" does not include machinery the sole
justification for the installation of which is the fact that such machinery is
required to meet temperature or humidity requirements which are essential for
the operation of other machinery or the processing of materials or
foodstuffs. Machinery may meet the "sole justification" test
provided by the preceding sentence even though it incidentally provides for the
comfort of employees or serves to an insubstantial degree areas where such
temperature or humidity requirements are not essential.
(4) Personal property associated with the use of the
real property--(i) In general. The term "real property"
includes movable walls, furnishings, and other personal property associated
with the use of the real property. Personal property is associated with
the use of real property only if it is described in one of the categories set
forth in subdivisions (A) through (D) of this paragraph (b)(4)(i).
"Personal property" for purposes of this section means any property
that constitutes, "tangible personal property" under the principles
of § 1.48-1(c), without regard to whether such property qualifies as section 38
property. Such property will be associated with the use of the real
property only where both the personal property and the United States real
property interest with which it is associated are held by the same person or by
related persons within the meaning of § 1.897-1(i). For purposes of this
paragraph (b)(4)(i), property is used "predominantly" in a named
activity if it is devoted to that activity during at least half of the time in
which it is in use during a calendar year.
(A) Property used in mining, farming, and
forestry. Personal property is associated with the use of real property
if it is predominantly used to exploit unsevered natural products in or upon
the land. Such property includes mining equipment used to extract ores,
minerals, and other natural deposits from the ground. It also includes
any property used to cultivate the soil and harvest its products, such as farm
machinery, draft animals, and equipment used in the growing and cutting of
timber. However, personal property used to process or transport minerals,
crops, or timber after they are severed from the land is not associated
personal property.
(B) Property used in the improvement of real
property. Personal property is associated with the use of real property
if it is predominantly used to construct or otherwise carry out improvements to
real property. Such property includes equipment used to alter the natural
contours of the land, equipment used to clear and prepare raw land for
construction, and equipment used to carry out the construction of improvements.
(C) Property used in the operation of a lodging
facility. Personal property is associated with the use of real property
if it is predominantly used in connection with the operation of a lodging
facility. Property that is used in connection with the operation of a
lodging facility includes property used in the living quarters of such
facility, such as beds and other furniture, refrigerators, ranges and other
equipment, as well as property used in the common areas of such facility, such
as lobby furniture and laundry equipment. Such property constitutes personal
property associated with the use of real property in the hands of the owner or
operator of the facility, not of the tenant or guest. A lodging facility
is an apartment house or apartment, hotel, motel, dormitory, residence, or any
other facility (or part of a facility) predominantly used to provide, at a
charge, living and/or sleeping accommodations, whether on daily, weekly,
monthly, annual, or other basis. The term "lodging facility"
does not include a personal residence occupied solely by its owner, or a
facility used primarily as a means of transportation (such as an aircraft,
vessel, or a railroad car) or used primarily to provide medical or convalescent
services, even though sleeping accommodations are provided. Nor does the term
include temporary living quarters provided by an employer due to the
unavailability of lodgings within a reasonable distance of a worksite (such as
a mine or construction project). The term "lodging facility"
does not include any portion of a facility that constitutes a nonlodging
commercial facility and that is available to persons not using the lodging
facility on the same basis that it is available to tenants of the lodging
facility. Examples of nonlodging commercial facilities include
restaurants, drug stores, and grocery stores located in a lodging facility.
(D) Property used in the rental of furnished office
and other work space. Personal property is associated with the use of
real property if it is predominantly used by a lessor to provide furnished
office or other work space to lessees. Property that is so used includes
office furniture and equipment included in the rental of furnished space.
Such property constitutes personal property associated with the use of real
property in the hands of the lessor, not of the lessee.
(ii) Dispositions of associated personal property--(A)
In general. Personal property that has become associated with the use of
a real property interest shall itself be treated as a real property interest
upon its disposition, unless either:
(1) The personal property is disposed of more than one
year before the disposition of any present right to use or occupy the real
property with which it was associated (and subject to the provisions of
subdivision (B) of this paragraph (b)(4)(ii));
(2) The personal property is disposed of more than one
year after the disposition of all present rights to use or occupy the real
property with which it was associated (and subject to the provisions of
subdivision (C) of this paragraph (b)(4)(ii)); or
(3) The personal property and the real property with
which it was associated are separately sold to persons that are related neither
to the transferor nor to one another (and subject to the provisions of
subdivision (D) of this paragraph (b)(4)(ii)).
(B) Personalty property disposed of one year before
realty. A transferor of personal property associated with the use of real
property need not treat such property as a real property interest upon
disposition if on the date of disposition the transferor does not expect or
intend to dispose of the real property until more than one year later.
However, if the real property is in fact disposed of
within the following year, the transferor must treat the personal property as
having been a real property interest as of the date on which the personalty was
disposed of. If the transferor had not previously filed an income tax
return, a return must be filed and tax paid, together with any interest due
thereon, by the later of the date on which a tax return or payment is actually
due (with extensions), or the 60th day following the date of disposition.
If the transferor had previously filed an income tax return, an amended return
must be filed and tax paid, together with any interest due thereon, by the
later of the dates specified above. Such a transferor may be liable to
penalties for failure to file, for late payment of tax, or for understatement
of liability, but only if the transferor knew or had reason to anticipate that
the real property would be disposed of within one year of the disposition of
the associated personal property.
(C) Personalty disposed of one year after
realty. A disposition of real property shall be disregarded for purposes
of subdivision (A)(2) of this paragraph (b)(4)(ii) if any right to use or
occupy the real property is reacquired within the one-year period referred to
in that subdivision. However, the disposition shall not be disregarded if such
reacquisition is made in foreclosure of a mortgage or other security interest,
in the exercise of a contractual remedy, or in the enforcement of a
judgment. If, however, the reacquisition of the property is made pursuant
to a plan the principal purpose of which is the avoidance of the provisions of
section 897, 1445, or 6039C and the regulations thereunder, then the initial
disposition shall be disregarded for purposes of subdivision (A)(2) of this
paragraph (b)(4)(ii).
(D) Separate dispositions of personalty and
realty. A transferor of personal property associated with the use of real
property need not treat such property as a real property interest upon
disposition if within 90 days before or after such disposition the transferor
separately disposes of the real property interest to persons that are related
neither to the transferor nor to the purchaser of the personal property.
A transferor may rely upon this rule unless the transferor knows or has reason
to know that the purchasers of the real property and the personal property--
(1) Are related persons; or
(2) Intend to reassociate the personal property with
the use of the real property within one year of the date of disposition of the
personal property.
(E) Status of property in hands of transferee.
Personal property that has been associated with the use of real property and
that is sold to an unrelated party will be treated as real property in the
hands of the transferee only if the personal property becomes associated with
the use of real property held or acquired by the transferee, in the manner
described in paragraph (b)(4)(i) of this section.
(iii) Determination dates. The determination of
whether personal property is personal property associated with the use of real
property as defined in this paragraph (b)(4) is to be made on the date the
personal property is disposed of and on each applicable determination
date. See § 1.897-2(c).
(c) United States real property interest--(1) In
general. The term "United States real property interest" means
any interest, other than an interest solely as a creditor, in either:
(i) Real property located in the United States or the
Virgin Islands, or
(ii) A domestic corporation unless it is established
that the corporation was not a U.S. real property holding corporation within
the period described in section 897(c)(1)(A)(ii).
In addition, for the limited purpose of determining
whether any corporation is a U.S. real property holding corporation, the term
"United States real property interest" means an interest, other than
an interest solely as a creditor, in a foreign corporation unless it is
established that the foreign corporation is not a U.S. real property holding
corporation within the period prescribed in section 897(c)(1)(A)(ii). See
§ 1.897-2 for rules regarding the manner of establishing that a corporation is
not a United States real property holding corporation.
(2) Exceptions and special rules--(i)
Domestically-controlled REIT. An interest in a domestically-controlled
real estate investment trust (REIT) is not a U.S. real property interest.
A domestically-controlled REIT is one in which less than 50 percent of the fair
market value of the outstanding stock was directly or indirectly held by
foreign persons during the five-year period ending on the applicable
determination date (or the period since June 18, 1980, if shorter). For
purposes of this determination the actual owners of stock, as determined under
§ 1.857-8, must be taken into account.
(ii) Corporation that has disposed of all U.S. real
property interests. The term "United States real property interest"
does not include an interest in a corporation which has disposed of all its
U.S. real property interests in transactions in which the full amount of gain,
if any, was recognized, as provided as section 897(c)(1)(B). See §
1.897-2(f) for rules regarding the requirements of section 897(c)(1)(B).
(iii) Publicly-traded corporations. If, at any
time during the calendar year, any class of stock of a domestic corporation is
regularly traded on an established securities market, an interest in such
corporation shall be treated as a U.S. real property interest only in the case
of:
(A) A regularly traded interest owned by a person who
beneficially owned more than 5 percent of the total fair market value of that
class of interests at any time during the five-year period ending either on the
date of disposition of such interest or other applicable determination date (or
the period since June 18, 1980, if shorter), or
(B) [Reserved]
Separate non-regularly traded interests that were
acquired in transactions more than three years apart shall not be cumulated
pursuant to this rule. In determining whether a shareholder holds 5
percent of a class of stock in a corporation (or any other interest of an
equivalent fair market value), section 318(a) shall apply (except that sections
318(a)(2)(C) and (3)(C) are applied by substituting the phrase "5
percent" for "50 percent").
(iv) Publicly traded partnerships and trusts. If
any class of interests in a partnership or trust is, within the meaning of §
1.897-1(m) and (n), regularly traded on an established securities market, then
for purposes of sections 897(g) and 1445 and § 1.897-2(d) and (e) an interest
in the entity shall not be treated as an interest in a partnership or
trust. Instead, such an interest shall be subject to the rules applicable
to interests in publicly traded corporations pursuant to paragraph (c)(2)(iii)
of this section. Such interests can be real property interests in the
hands of a person that holds a greater than 5 percent interest.
Therefore, solely for purposes of determining whether greater than 5 percent
interests in such an entity constitute U.S. real property interests the
disposition of which is subject to tax, the entity is required to determine
pursuant to the provisions of § 1.897-2 whether the assets it holds would cause
it to be classified as a U.S. real property holding corporation if it were a
corporation. The treatment of dispositions of U.S. real property
interests by publicly traded partnerships and trusts is not affected by the
rules of this paragraph (c)(2)(iv); by reason of the operation of section
897(a), foreign partners or beneficiaries are subject to tax upon their
distributive share of any gain recognized upon such dispositions by the
partnership or trust. The rules of this paragraph (c)(2)(iv) are
illustrated by the following example.
Example. PTP is a partnership one class of
interests in which is regularly traded on an established securities
market. A is a nonresident alien individual who owns 1 percent of a class
of limited partnership interests in PTP. B is a nonresident alien
individual who owns 10 percent of the same class of limited partnership
interests in PTP. On July 1, 1986, A and B sell their interests in
PTP. Pursuant to the rules of this paragraph (c)(2)(iv), neither
disposition is treated as the disposition of a partnership interest subject to
the provisions of section 897(g). Instead, A and B are treated as having
disposed of interests in a publicly traded corporation. Therefore, pursuant
to the rule of paragraph (c)(2)(iii) of this section, A's disposition of a 1
percent interest has no consequences under section 897. However, B's
disposition of a 10 percent interest will constitute the disposition of a U.S.
real property interest subject to tax by reason of the operation of section 897
unless it is established pursuant to the rules of § 1.897-2 that the interest
is not a U.S. real property interest.
(d) Interest other than an interest solely as a
creditor--(1) In general. This paragraph defines an interest other than
an interest solely as a creditor, with respect to real property, and with
respect to corporations, partnerships, trusts, and estates. An interest
solely as a creditor either in real property or in a domestic corporation does
not constitute a United States real property interest. Similarly, where
one corporation holds an interest solely as a creditor in a second corporation
or in a partnership, trust, or estate, that interest will be disregarded for
purposes of determining whether the first corporation is a U.S. real property
holding corporation (except to the extent that such interest constitutes an
asset used or held for use in a trade or business, in accordance with rules of
§ 1.897-1(f)). In addition, the disposition of an interest solely as a
creditor in a partnership, trust, or estate is not subject to sections 897,
1445, and 6039C. Whether an interest is considered debt under any
provisions of the Code is not determinative of whether it constitutes an
interest solely as a creditor for purpose of sections 897, 1445, and 6039C and
the regulations thereunder.
(2) Interests in real property other than solely as
creditor--(i) In general. An interest in real property other than an
interest solely as a creditor includes a fee ownership, co-ownership, or
leasehold interest in real property, a time sharing interest in real property,
and a life estate, remainder, or reversionary interest in such property.
The term also includes any direct or indirect right to share in the appreciation
in the value, or in the gross or net proceeds or profits generated by, the real
property.
A loan to an individual or entity under the terms of
which a holder of the indebtedness has any direct or indirect right to share in
the appreciation in value of, or the gross or net proceeds or profits generated
by, an interest in real property of the debtor or of a related person is, in
its entirety, an interest in real property other than solely as a
creditor. An interest in production payments described in section 636
does not generally constitute an interest in real property other than solely as
a creditor. However, a right to production payments shall constitute an
interest in real property other than solely as a creditor if it conveys a right
to share in the appreciation in value of the mineral property. A
production payment that is limited to a quantum of mineral (including a
percentage of recoverable reserves produced) or a period of time will be
considered to convey a right to share in the appreciation in value of the
mineral property. The rules of this paragraph (d)(2)(i) are illustrated
by the following example.
Example. A, a U.S. citizen, purchases a condominium
unit located in the United States for $500,000. A makes a $100,000 down
payment and borrows $400,000 from B, a foreign person, to pay the balance of
the purchase price. Under the terms of the loan, A is to pay B 13 percent
annual interest each year for 10 years and 35 percent of the appreciation in
the fair market value of the condominium at the end of the 10-year
period. Because B has a right to share in the appreciation in value of
the condominium, B has an interest other than solely as a creditor in the
condominium. B's entire interest in the obligation from A, therefore, is
a United States real property interest.
(ii) Special rule--(A) Installment obligations.
A right to installment or other deferred payments from the disposition of an
interest in real property will constitute an interest solely as a creditor if
the transferor elects not to have the installment method of section 453(a)
apply, any gain or loss is recognized in the year of disposition, and all tax
due is timely paid. See section 1445 and regulations thereunder for
further guidance concerning the availability of installment sale treatment
under section 453. If an agreement for the payment of tax with respect to
an installment sale is entered into with the Internal Revenue Service pursuant
to section 1445, that agreement may specify whether or not the installment obligation
will constitute an interest solely as a creditor. If an installment
obligation constitutes an interest other than solely as a creditor then the
receipt of each payment shall be treated as the disposition of an interest in
real property that is subject to section 897(a) to the extent of any gain
required to be taken into account pursuant to section 453.
If the original holder of an installment obligation
that constitutes an interest other than solely as a creditor subsequently
disposes of the obligation to an unrelated party and recognizes gain or loss
pursuant to section 453B, the obligation will constitute an interest in real
property solely as a creditor in the hands of the subsequent holder.
However, if the obligation is disposed of to a related person and the full
amount of gain realized upon the disposition of the real property has not been
recognized upon such disposition of the installment obligation, then the
obligation shall continue to be an interest in real property other than solely
as a creditor in the hands of the subsequent holder subject to the rules of
this paragraph (d)(2)(ii)(A).
In addition, if the obligation is disposed of to any
person for a principal purpose of avoiding the provisions of sections 897,
1445, or 6039C, then the obligation shall continue to be an interest in real
property other than solely as a creditor in the hands of the subsequent holder
subject to the rules of this paragraph (d)(2)(ii)(A). However, rights to
payments arising from dispositions that took place before June 19, 1980, shall
in no event constitute interests in real property other than solely as a
creditor, even if such payments are received after June 18, 1980. In
addition, rights to payments arising from dispositions to unrelated parties
that took place before January 1, 1985, and that were not subject to U.S. tax
pursuant to the provisions of a U.S. income tax treaty, shall not constitute
interests in real property other than solely as a creditor, even if such
payments are received after December 31, 1984.
(B) Options. An option, a contract or a right of
first refusal to acquire any interest in real property (other than an interest
solely as a creditor) will itself constitute an interest in real property other
than solely as a creditor.
(C) Security interests. A right to repossess or
foreclose on real property under a mortgage, security agreement, financing
statement, or other collateral instrument securing a debt will not be
considered a reversionary interest in, or a right to share in the appreciation
in value of or gross or net proceeds or profits generated by, an interest in
real property. Thus, no such right of repossession or foreclosure will of
itself cause an interest in real property which is otherwise an interest solely
as a creditor to become an interest other than solely as a creditor. In
addition, a person acting as mortgagee in possession shall not be considered to
hold an interest in real property other than solely as a creditor, if the
mortgagee's interest in the property otherwise constitutes an interest solely
as a creditor.
(D) Indexed interest rates. An interest will not
constitute a right to share in the appreciation in the value of, or gross or
net proceeds or profits generated by, real property solely because it bears a
rate of interest that is tied to an index of any kind that is intended to
reflect general inflation or deflation of prices and interest rates (e.g., the
Consumer Price Index). However, where an interest in real property bears a rate
of interest that is tied to an index the principal purpose of which is to
reflect changes in real property values, the real property interest will be
considered an indirect right to share in the appreciation in value of, or gross
or net proceeds or profits generated by, real property. Such an indirect
right constitutes an interest in real property other than solely as a creditor.
(E) Commissions. A right to payment of a
commission, brokerage fee, or similar charge for professional services rendered
in connection with the arrangement or financing of a purchase, sale, or lease
of real property does not constitute a right to share in the appreciation in
value of, or gross or net proceeds or profits of, real property solely because
it is based upon a percentage of the purchase price or rent. Thus, a
right to a commission earned by a real estate agent based on a percentage of
the sales price does not constitute an interest in real property other than
solely as a creditor.
However, a right to a commission, brokerage fee, or
similar charge will constitute an interest other than solely as a creditor if
the total amount of the payment is contingent upon appreciation, proceeds, or
profits of the real property occurring or arising after the date of the
transaction with respect to which the professional services were
rendered. For example, a commission earned in connection with the
purchase of a real property interest that is contingent upon the amount of gain
ultimately realized by the purchaser will constitute an interest in real
property other than solely as a creditor.
(F) Trustees' fees, etc. A right to payment of
reasonable compensation for services rendered as a trustee, as an administrator
of an estate, or in a similar capacity does not constitute a right to share in
the appreciation in the value of, or gross or net proceeds or profits of, real
property solely because the assets of the trust or estate include U.S. real
property interests.
(3) Interest in an entity other than solely as a
creditor--(i) In general. For purposes of sections 897, 1445, and 6039C,
an interest in an entity other than an interest solely as a creditor is--
(A) Stock of a corporation;
(B) An interest in a partnership as a partner within
the meaning of section 761(b) and the regulations thereunder;
(C) An interest in a trust or estate as a beneficiary
within the meaning of section 643(c) and the regulations thereunder or an
ownership interest in any portion of a trust as provided in section 671 through
679 and the regulations thereunder;
(D) An interest which is, in whole or in part, a
direct or indirect right to share in the appreciation in value of an interest
in an entity described in subdivision (A), (B), or (C) of this paragraph
(d)(3)(i) or a direct or indirect right to share in the appreciation in value of
assets of, or gross or net proceeds or profits derived by, the entity; or
(E) A right (whether or not presently exercisable)
directly or indirectly to acquire, by purchase, conversion, exchange, or in any
other manner, an interest described in subdivision (A), (B), (C), or (D) of
this paragraph (d)(3)(i).
(ii) Special rules--(A) Installment obligations.
A right to installment or other deferred payments from the disposition of an
interest in an entity will constitute an interest solely as a creditor if the
transferor elects not to have the installment method of section 453(a) apply,
any gain or loss is recognized in the year of disposition, and tax due is
timely paid. See section 1445 and regulations thereunder for further
guidance concerning the availability of installment sale treatment under
section 453. If an agreement for the payment of tax with respect to an
installment sale is entered into with the Internal Revenue Service pursuant to
section 1445, that agreement may specify whether or not the installment
obligation will constitute an interest solely as a creditor. If an
installment obligation constitutes an interest other than solely as a creditor
then the receipt of each payment shall be treated as the disposition of such an
interest and shall be subject to section 897(a) to the extent that:
(1) It constitutes the disposition of a U.S. real
property interest and
(2) Gain or loss is required to be taken into account
pursuant to section 453. Such treatment shall apply to payments arising
from dispositions of interests in a corporation any class of the stock of which
is regularly traded on an established securities market, but only in the case
of a disposition of any portion of an interest described in paragraph
(c)(2)(iii)(A) or (B) of this section. If the original holder of an
installment obligation that constitutes an interest other than solely as a
creditor subsequently disposes of the obligation to an unrelated party and
recognizes gain or loss pursuant to section 453B, the obligation will constitute
an interest in the entity solely as a creditor in the hands of the subsequent
holder. However, if the obligation is disposed of to a related person and
the full amount of gain realized upon the disposition of the interest in the
entity has not been recognized upon such disposition of the installment
obligation, then the obligation shall continue to be an interest in the entity
other than solely as a creditor in the hands of the subsequent holder subject
to the rules of this paragraph (d)(3)(ii)(A). In addition, if the
obligation is disposed of to any person for a principal purpose of avoiding the
provisions of section 897, 1445, or 6039C, then the obligation shall continue
to be an interest in the entity other than solely as a creditor in the hands of
the subsequent holder subject to the rules of this paragraph
(d)(3)(ii)(A). However, rights to payments arising from dispositions that
took place before June 19, 1980, shall in no event constitute interests in an
entity other than solely as a creditor, even if such payments are received
after June 18, 1980. In addition, such treatment shall not apply to
payments arising from dispositions to unrelated parties that took place before
January 1, 1985, and that were not subject to U.S. tax pursuant to the
provisions of a U.S. income tax treaty, regardless of when such payments are
received.
(B) Contingent interests. The interests
described in subdivision (D) of paragraph (d)(3)(i) of this section include any
right to a payment from an entity the amount of which is contingent on the
appreciation in value of an interest described in subdivision (A), (B), or (C)
of paragraph (d)(3)(i) of this section or which is contingent on the
appreciation in value of assets of, or the general gross or net proceeds or profits
derived by, such entity. The right to such a payment is itself an
interest in the entity other than solely as a creditor, regardless of whether
the holder of such right actually holds an interest in the entity described in
subdivision (A), (B), or (C) of paragraph (d)(3)(i) of this section. For
example, a stock appreciation right constitutes an interest in a corporation
other than solely as a creditor even if the holder of such right actually holds
no stock in the corporation. However, the interests described in
subdivision (D) of paragraph (d)(3)(i) of this section do not include any right
to a payment that is (1) exclusively contingent upon and exclusively paid out
of revenues from sales of personal property (whether tangible or intangible) or
from services, or (2) exclusively contingent upon the resolution of a claim
asserted against the entity by a person related neither to the entity nor to
the holder of the interest.
(C) Security interests. A right to repossess or
foreclose on an interest in an entity under a mortgage, security agreement,
financing statement, or other collateral instrument securing a debt will not of
itself cause an interest in an entity which is otherwise an interest solely as
a creditor to become an interest other than solely as a creditor.
(D) Royalties. The interests described in
subdivision (D) of paragraph (d)(3)(i) of this section do not include
rights to payments representing royalties, license fees, or similar charges for
the use of patents, inventions, formulas, copyrights, literary, musical or
artistic compositions, trademarks, trade names, franchises, licenses, or
similar intangible property.
(E) Commissions. The interests described in
subdivision (D) of paragraph (d)(3)(i) of this section do not include a
right to a commission, brokerage fee or similar charge for professional
services rendered in connection with the purchase or sale of an interest in an
entity. However, a right to such a payment will constitute an interest
other than solely as a creditor if the total amount of the payment is
contingent upon appreciation in value of assets of, or proceeds or profits
derived by, the entity after the date of the transaction with respect to which
the payment was earned.
(F) Trustee's fees. The interests described in
subdivision (D) of paragraph (d)(3)(i) of this section do not include a
right to payment representing reasonable compensation for services rendered as
a trustee, as an administrator of an estate, or in a similar capacity.
(4) Aggregation of interests. If a person holds
both interests solely as a creditor and interests other than solely as a
creditor in real property or in an entity, those interests will generally be
treated as separate and distinct interests. However, such interests shall
be aggregated and treated as interests other than solely as a creditor in their
entirety if the interest solely as a creditor has been separated from, or
acquired separately from, the interest other than solely as a creditor, for a
principal purpose of avoiding the provisions of section 897, 1445, or 6039C by
causing one or more of such interests to be an interest solely as a
creditor. The existence of such a purpose will be determined with
reference to all the facts and circumstances. Where an interest solely as a
creditor has arm's-length interest and repayment terms it shall in no event be
aggregated with and treated as an interest other than solely as a
creditor. For purposes of this paragraph (d)(4), an interest rate that
does not exceed 120 percent of the applicable Federal rate (as defined in
section 1274(d)) shall be presumed to be an arm's-length interest rate.
For purposes of applying the rules of this paragraph (d)(4), a person shall be
treated as holding any interests held by a related person within the meaning of
§ 1.897-1(i).
(5) "Interest" means "interest other
than solely as a creditor." Unless otherwise stated, the term
"interest" as used with regard to real property or with regard to an
entity hereafter in the regulations under sections 897, 1445, and 6039C, means
an interest in such real property or entity other than an interest solely as a
creditor.
(e) Proportionate share of assets held by an
entity--(1) In general. A person that holds an interest in an entity is
for certain purposes treated as holding a proportionate or pro rata share of
the assets held by the entity. Such proportionate share must be
calculated, in accordance with the rules of this paragraph, for the following
purposes.
(i) In determining whether a corporation is a U.S.
real property holding corporation--
(A) A person holding an interest in a partnership,
trust, or estate is treated as holding a proportionate share of the assets held
by the partnership, trust, or estate (see § 897-2(e)(2)), and
(B) A corporation that holds a controlling interest in
a second corporation is treated as holding a proportionate share of the assets
held by the second corporation (see § 1.897-2(e)(3)).
(ii) In determining reporting obligations that may be
imposed under section 6039C, the holder of an interest in a partnership, trust,
or estate is treated as owning a proportionate share of the U.S. real property
interests held by the partnership, trust, or estate.
(2) Proportionate share of assets held by a
corporation or partnership--(i) In general. A person's proportionate or
pro rata share of assets held by a corporation or partnership is determined by
multiplying--
(A) The person's percentage ownership interest in the
entity, by
(B) The fair market value of the assets held by the
entity (or the book value of such assets, in the case of a determination
pursuant to § 1.897-2(b)(2)).
(ii) Percentage ownership interest. A person's
percentage ownership interest in a corporation or partnership is the percentage
equal to the ratio of (A) the sum of the liquidation values of all interests in
the entity held by the person to (B) the sum of the liquidation values of all
outstanding interest in the entity. The liquidation value of an interest
in an entity is the amount of cash and the fair market value of any property
that would be distributed with respect to such interest upon the liquidation of
the entity after satisfaction of liabilities to persons having interests in the
entity solely as creditors. With respect to an entity that has interests
outstanding that grant a presently-exercisable option to acquire or right to
convert into or otherwise acquire an interest in the entity other than solely
as a creditor, the liquidation value of all interests in such entity shall be
calculated as though such option or right had been exercised, giving effect
both to the payment of any consideration required to exercise the option or
right and to the issuance of the additional interest.
The fair market value of the assets of the
entity, the amount of cash held by the entity, and the amount of liabilities to
persons having interests solely as creditors if determined for this purpose on
the date with respect to which the percentage ownership interest is determined.
(iii) Examples. The rules of this paragraph
(e)(2) are illustrated by the following examples.
Example 1. Corporation K's only assets are stock
and securities with a fair market value as of the applicable determination date
of $20,000,000 K's assets are subject to liabilities of $10,000,000.
Among K's liabilities are a $1,000,000 loan from L, under the terms of which L
is entitled, upon payment of the loan principal, to a profit share equal to 10
percent of the excess of the fair market value of K's assets over $18,000,000, but
only if all other corporate liabilities have been paid. K has two classes
of stock, common and preferred. PS1 and PS2 each own 100 of the 200
outstanding shares of preferred stock. CS1 and CS2 each own 500 of the
1,000 outstanding shares of common stock. Each preferred shareholder is
entitled to $10,000 per share of preferred stock upon liquidation, subject to
payment of all corporate liabilities and to any amount owed to L, but before
any common shareholder is paid. The liquidation value of L's interest in
K, which constitutes an interest other than an interest solely as a creditor,
is $1,200 ($1,000,000 principal of the loan to K plus $200,000 (10 percent of
the excess of $20,000,000 over $18,000,000). The liquidation value
of each of PS1's and PS2's blocks of preferred stock is $1,000,000 ($10,000
times 100 shares each). The liquidation value of each of CS1's and CS2's blocks
of common stock is $3,900,000 [$20,000,000 (the total fair market value of K's
assets)-- $9,000,000 (liabilities to creditors other than L)--$1,200,000 (L's
liquidation value)--$2,000,000 (PS1's and PS2's liquidation value) times 50
percent (the percentage of common stock owned by each)]. The sum of the
liquidation values of all of the outstanding interests in K (i.e., interests other
than solely as a creditor) is $11,000,000 [$1,200,000 (L's liquidation value) +
$2,000,000 (PS1's and PS2's liquidation values) + $7,800,000 (CS1's and CS2's
liquidation values)]. Each of CS1's and CS2's percentage ownership
interests in K is 35.5 percent ($3,900,000 divided by $11,000,000). Each
of PS1's and PS2's percentage ownership interests in K is 9 percent ($1,000,000
divided by $11,000,000). L's percentage ownership interest in K is 11
percent ($1,200,000 divided by $11,000,000).
Example 2. A, a U.S. person, and B, a foreign
person are partners in a partnership the only asset of which is a parcel of
undeveloped land located in the United States that was purchased by the
partnership in 1980 for $300,000. The partnership has no liabilities, and its
capital is $300,000. A's and B's interests in the capital of the
partnership are 25 percent and 75 percent, respectively, and A and B each has a
50 percent profit interest in the partnership. The partnership agreement
provides that upon liquidation any unrealized gain will be distributed in
accordance with the partners' profit interest. In 1984 the partnership
has no items of income or deduction, and the fair market value of its parcel of
undeveloped land is $500,000. In 1984 the percentage ownership interest
of A in the partnership is 35 percent [the ratio of $100,000 (the liquidation
value of A's profit interest in 1984) plus $75,000 (the liquidation value of
A's 25 percent interest in the partnership's $300,000 capital) to $500,000 (the
sum of the liquidation values of all outstanding interests in the
partnership)]. The percentage ownership interest of B in the partnership
in 1984 is 65 percent [the ratio of $325,000 (B's $100,000 profit interest plus
his $225,000 capital interest) to $500,000].
(3) Proportionate share of assets held by trusts and
estates--(i) In general. A person's proportionate or pro rata share of
assets held by a trust or estate is determined by multiplying--
(A) The person's percentage ownership interest in the
trust or estate, by
(B) The fair market value of the assets held by the
trust or estate (or the book value of such assets, in the case of a
determination pursuant to § 1.897- 2(b)(2)).
(ii) Percentage ownership interest--(A) General
rule. A person's percentage ownership interest in a trust or an
estate--is the percentage equal to the ratio of:
(1) The sum of the actuarial values of such person's
interests in the cash and other assets held by the trust or estate after
satisfaction of the liabilities of the trust or estate to persons holding
interests in the trust or estate solely as creditors, to (2) the entire amount
of such cash and other assets after satisfaction of liabilities to persons
holding interests in the trust or estate solely as creditors. For purposes
of calculating this ratio, the fair market value of the trust's or estate's
assets, the amount of cash held by the trust or estate, and the amount of the
liabilities to persons having interests solely as creditors is determined on
the date with respect to which the percentage ownership interest is
determined. With respect to a trust or estate that has interests
outstanding that grant a presently-exercisable option to acquire or right to
convert into or otherwise acquire an interest in the trust or estate other than
solely as a creditor, the liquidation value of all interests in such entity
shall be calculated as though such option or right had been exercised, giving
effect both to the payment of any consideration required to exercise the option
or right and to the issuance of the additional interest. With respect to
a trust or estate that has interests outstanding that entitle any person to a
distribution of U.S. real property interests upon liquidation that is
disproportionate to such person's interest in the total assets of the trust or
estate, such disproportionate right shall be disregarded in the calculation of
the interest-holders' proportionate share of the U.S. real property interests
held by the entity. For purposes of determining his own percentage
ownership interest in a trust, a grantor or other person will be treated as
owning any portion of the trust's cash and other assets which such person is
treated as owning under sections 671 through 679.
(B) Discretionary trusts and estates. In determining
percentage ownership interest in a trust or an estate, the sum of the
definitely ascertainable actuarial values of interests in the cash and the
other assets of the trust or estate held by persons in existence on the date
with respect to which such determination is made must equal the amount in
paragraph (e)(3)(ii)(A)(2) of this section. If the amount in paragraph
(e)(3)(ii)(A)(2) of this section exceeds the sum of the definitely
ascertainable actuarial values of the interests held by persons in existence on
the determination date, the excess will be considered to be owned in total by
each beneficiary who is in existence on such date, whose interest in the excess
is not definitely ascertainable and who is potentially entitled to such
excess. However, such excess shall not be considered to be owned in total
by each beneficiary if the discretionary terms of the trust or estate were
included for a principal purpose of avoiding the provisions of section 897,
1445, or 6039C by causing assets other than U.S. real property interests to be
attributed in total to each beneficiary. The rules of this paragraph
(e)(3) are illustrated by the following example.
Example. A, a U.S. person, established a trust
on December 31, 1984, and contributed real property with a fair market value of
$10,000 to the trust. The terms of that trust provided that the trustee, a bank
that is unrelated to A, at its discretion may retain trust income or may
distribute it to X, a foreign person, or to the head of state of any country other
than the United States. The remainder upon the death of X is to go in
equal shares to such of Y and Z, both foreign persons, as survive X. On
December 31, 1984, the total value of the trust's assets is $10,000. On
the same date, the actuarial values of the remainder interests of Y and Z in
the corpus of the trust are definitely ascertainable. They are $1,000 and
$500, respectively. Neither the income interest of X nor of the head of
state of any country other than the United States has a definitely
ascertainable actuarial value on December 31, 1984. The interests of Y and Z in
the income portion of the trust similarly have no definitely ascertainable
actuarial values on such date since the income may be distributed rather than
retained by the trust. Since the sum of the actuarial values of
definitely ascertainable interests of persons in existence ($1,500) is less
than $10,000, the difference ($8,500) is treated as owned by each beneficiary
who is in existence on December 31, 1984, and who is potentially entitled to
such excess. Therefore, X, Y, Z, and the head of state of any country
other than the United States are each considered as owning the entire $8,500
income interest in the trust. On December 31, 1984, the total actuarial
value of X's interest is $8,500, and his percentage ownership interest is 85
percent. The total actuarial value of Y's interest in the trust is $9,500
($1,000 plus $8,500), and his percentage ownership interest is 95
percent. The total actuarial value of Z's interest is $9,000 ($500 plus
$8,500), and his percentage ownership interest is 90 percent. The
actuarial value of the interest of the head of state of each country other than
the United States is $8,500, and his percentage ownership interest is 85
percent.
(4) Dates with respect to which percentage ownership
interests are determined. The dates with respect to which percentage
ownership interests are determined are the applicable determination dates
outlined in § 1.897-2 or in regulations under section 6039C.
(f) Asset used or held for use in a trade or
business--(1) In general. The term "asset used or held for use in a
trade or business" means--
(i) Property, other than a U.S. real property
interest, that is--
(A) Stock in trade of an entity or other property of a
kind which would properly be included in the inventory of the entity if on hand
at the close of the taxable year, or property held by the entity primarily for
sale to customers in the ordinary course of its trade or business, or
(B) Depreciable property used or held for use in the
trade or business, as described in section 1231(b)(1) but without regard to the
holding period limitations of section 1231(b), or
(C) Livestock, including poultry, used or held for use
in a trade or business for draft, breeding, dairy, or sporting purposes, and
(ii) Goodwill and going concern value, patents,
inventions, formulas copyrights, literary, musical, or artistic compositions,
trademarks, trade names, franchises, licenses, customer lists, and similar intangible
property, but only to the extent that such property is used or held for use in
the entity's trade or business and subject to the valuation rules of § 1.897-
1(o)(4), and
(iii) Cash, stock, securities, receivables of all
kinds, options or contracts to acquire any of the foregoing, and options or
contracts to acquire commodities, but only to the extent that such assets are
used or held for use in the corporation's trade or business and do not
constitute U.S. real property interests.
(2) Used or held for use in a trade or business.
An asset is used or held for use in an entity's trade or business if it is,
under the principles of § 1.864- 4(c)(2)--
(i) Held for the principal purpose of promoting the
present conduct of the trade or business,
(ii) Acquired and held in the ordinary course of the
trade or business, as, for example, in the case of an account or note
receivable arising from that trade or business (including the performance of
services), or
(iii) Otherwise held in a direct relationship to the
trade or business.
In determining whether an asset is held in a direct
relationship to the trade or business, consideration shall be given to whether
the asset is needed in that trade or business. An asset shall be
considered to be needed in a trade or business only if the asset is held to
meet the present needs of that trade or business and not its anticipated future
needs. An asset shall be considered as needed in the trade or business
if, for example, the asset is held to meet the operating expenses of that trade
or business. Conversely, an asset shall be considered as not needed in
the trade or business if, for example, the asset is held for the purpose of
providing for future diversification into a new trade or business, future
expansion of trade or business activities, future plant replacement, or future
business contingencies. An asset that is held to meet reserve or
capitalization requirements imposed by applicable law shall be presumed to be
held in a direct relationship to the trade or business.
(3) Special rules concerning liquid assets--(i) Safe
harbor amount. Assets described in paragraph (f)(1)(iii) of this section
shall be presumed to be used or held for use in a trade or business, in an
amount up to 5 percent of the fair market value of other assets used or held
for use in the trade or business. However, the rule of this paragraph
(f)(3)(i) shall not apply with respect to any assets described in paragraph
(f)(1)(iii) of this section that are held or acquired for the principal purpose
of avoiding the provisions of section 897 or 1445.
(ii) Investment companies. Assets described in
paragraph (f)(1)(iii) of this section shall be presumed to be used or held for
use in an entity's trade or business if the principal business of the entity is
trading or investing in such assets for its own account. An entity's
principal business shall be presumed to be trading or investing in assets
described in paragraph (f)(1)(iii) of this section if the fair market value of
such assets held by the entity equals or exceeds 90 percent of the sum of the
fair market values of the entity's U.S. real property interests, interests in
real property located outside the United States, assets otherwise used or held
for use in trade or business, and assets described in paragraph (f)(1)(iii) of
this section.
(4) Examples. The application of this paragraph
(f) may be illustrated by the following examples:
Example 1. M, a domestic corporation engaged in
industrial manufacturing, is required to hold a large current cash balance for
the purposes of purchasing materials and meeting its payroll. The amount
of the cash balance so required varies because of the fluctuating seasonal
nature of the corporation's business. In months when large cash balances
are not required, the corporation invests the surplus amount in U.S. Treasury
bills. Since both the cash and the Treasury bills are held to meet the
present needs of the business, they are held in a direct relationship to that
business, and, therefore, constitute assets used or held for use in the trade
or business.
Example 2. R, a domestic corporation engaged in
the manufacture of goods, engages a stock brokerage firm to manage securities
which were purchased with funds from R's general surplus reserves. The
funds invested in these securities are intended to provide for the future
expansion of R into a new trade or business. Thus, the funds are not
necessary for the present needs of the business; they are accordingly not
held in a direct relationship to the business and do not constitute assets used
or held for use in the trade or business.
Example 3. B, a federally chartered and
regulated bank, is required by law to hold substantial reserves of cash, stock,
and securities. Pursuant to the rule of paragraph (f)(2) of this section,
such assets are presumed to be held in a direct relationship to B's business,
and thus constitute assets used or held for use in the trade or business.
In addition, B holds substantial loan receivables which are acquired and held
in the ordinary course of its banking business. Pursuant to the rule of
paragraph (f)(1)(iii) of this section, such receivables constitute assets used
or held for use in the trade or business.
(g) Disposition. For purposes of sections 897,
1445, and 6039C, the term "disposition" means any transfer that
would constitute a disposition by the transferor for any purpose of the
Internal Revenue Code and regulations thereunder. The severance of crops
or timber and the extraction of minerals do not alone constitute the
disposition of a U.S. real property interest.
(h) Gain or loss. The amount of gain or loss
arising from the disposition of the U.S. real property interest shall be
determined as provided in section 1001(a) and (b). Such gain or loss
shall be subject to the provisions of section 897(a) and (b), unless a
nonrecognition provision is applicable pursuant to section 897(d) or (e) and
regulations thereunder. Amounts otherwise treated for Federal income tax
purposes as principal and interest payments on debt obligations of all kinds
(including obligations that are interests other than solely as a creditor) do
not give rise to gain or loss that is subject to section 897(a). However,
principal payments on installment obligations described in §§ 1.897-1(d)(2)(ii)(A)
and 1.897-1(d)(3)(ii)(A) do give rise to gain or loss that is subject to
section 897(a), to the extent such gain or loss is required to be recognized
pursuant to section 453. The rules of paragraphs (g) and (h) are
illustrated by the following examples.
Example 1. Foreign individual C has an undivided
fee interest in a parcel of real property located in the United States.
The fair market value of C's interest is $70,000, and C's basis in such
interest is $50,000. The only liability to which the real property is
subject is the liability of $65,000 secured by a mortgage in the same
amount. C transfers his fee interest in the property subject to the
mortgage by gift to D. C realizes $15,000 of gain upon such
transfer. As a transfer by gift constitutes a disposition for purposes of
the Code, and as gain is realized upon that transfer, the gift is a disposition
for purposes of sections 897, 1445, and 6039C and is subject to section 897(a)
to the extent of the gain realized. However, section 897(a) would not be
applicable to the transfer if the mortgage on the U.S. real property were equal
to or less than C's $50,000 basis, since the transfer then would not give rise
to the realization of gain or loss under the Internal Revenue Code.
Example 2. Foreign corporation Y makes a loan of
$1 million to domestic individual Z, secured by a mortgage on residential real
property purchased with the loan proceeds. The loan agreement provides
that Y is entitled to receive fixed monthly payments from Z, constituting
repayment of principal plus interest at a fixed rate. In addition, the
agreement provides that Y is entitled to receive a percentage of the
appreciation value of the real property as of the time that the loan is
retired. The obligation in its entirety is considered debt for Federal
income tax purposes. However, because of Y's right to share in the
appreciation in value of the real property, the debt obligation gives Y an
interest in the real property other than solely as a creditor. Nevertheless, as
principal and interest payments do not constitute gain under section 1001 and
paragraph (h) of this section, and both the monthly and final payments received
by Y are considered to consist solely of principal and interest for Federal
income tax purposes, section 897(a) shall not apply to Y's receipt of such
payments. However, Y's sale of the debt obligation to foreign corporation
A would give rise to gain that is subject to section 897(a).
(i) Related person. For purposes of sections
897, 1445, and 6039C, persons are considered to be related if they are partners
or partnerships described in section 707(b)(1) of the Code or if they are
related within the meaning of section 267(b) and (c) of the Code (except that
section 267(f) shall apply without regard to section 1563(b)(2)).
(j) Domestic corporation. The term
"domestic corporation" has the same meaning as set forth in section
7701(a)(3) and (4) and § 301.7701-5. For purposes of sections 897 and
6039C, it also includes a foreign corporation with respect to which an election
under section 897(i) and § 1.897-3 or section 897(k) and § 1.897-4 to be
treated as domestic corporation is in effect.
(k) [Reserved]
(l ) Foreign corporation. The term "foreign
corporation" has the meaning ascribed to such term in section 7701(a)(3)
and (5) and § 301.7701-5. For purposes of sections 897 and 6039C,
however, the term does not include a foreign corporation with respect to which
there is in effect an election under section 897(i) and § 1.897-3 or section
897(k) and § 1.897-4 to be treated as a domestic corporation.
(m) Established securities market. For purposes
of sections 897, 1445, and 6039C, the term "established securities
market" means--
(1) A national securities exchange which is registered
under section 6 of the Securities Exchange Act of 1934 (15 U.S.C. 78f),
(2) A foreign national securities exchange which is
officially recognized, sanctioned, or supervised by governmental authority, and
(3) Any over-the-counter market. An
over-the-counter market is any market reflected by the existence of an
interdealer quotation system. An interdealer quotation system is any
system of general circulation to brokers and dealers which regularly
disseminates quotations of stocks and securities by identified brokers or dealers,
other than by quotation sheets which are prepared and distributed by a broker
or dealer in the regular course of business and which contain only quotations
of such broker or dealer.
(n) [Reserved]
(o) Fair market value--(1) In general. For purposes
of sections 897, 1445, and 6039C only, the term "fair market value"
means the value of the property determined in accordance with the rules,
contained in this paragraph (o). The definition of fair market value
provided herein is not to be used in the calculation of gain or loss from the
disposition of a U.S. real property interest pursuant to section 1001. An
independent professional appraisal of the value of property must be submitted
only if such an appraisal is specifically requested in connection with the
negotiation of a security agreement pursuant to section 1445.
(2) Method of calculating fair market value--(i) In
general. The fair market value of property is its gross value (as defined
in paragraph (o)(2)(ii) of this section) reduced by the outstanding balance of
any debts secured by the property which are described in paragraph (o)(2)(iii)
of this section. See § 1.897-2(b) for the alternative use of book values
in certain limited circumstances.
(ii) Gross value. Gross value is the price at
which the property would change hands between an unrelated willing buyer and
willing seller, neither being under any compulsion to buy or to sell and both
having reasonable knowledge of all relevant facts. Generally, with
respect to trade or business assets, going concern value should be used as it
will provide the most accurate reflection of such a price. However,
taxpayers may use other methods of valuation if they can establish that such
method will provide a more accurate determination of gross value and if they
consistently apply such method to all assets to be valued. See
subdivisions (3) and (4) of this paragraph (o) for special rules with respect
to the valuation of leases and of intangible assets.
(iii) Debts secured by the property. The gross
value of property shall be reduced by the outstanding balance of debts that
are:
(A) Secured by a mortgage or other security interest
in the property that is valid and enforceable under the law of the jurisdiction
in which the property is located, and
(B) Either (1) incurred to acquire the property
(including long-term financing obtained in replacement of construction loans or
other short-term debt within one year of the acquisition or completion of the
property), or (2) otherwise incurred in direct connection with the property,
such as property tax liens upon real property or debts incurred to maintain or
improve property.
In addition, if any debt described in this paragraph
(o)(2)(iii) is refinanced for a valid business purpose (such as obtaining a
more favorable rate of interest), the principal amount of the replacement debt
does not exceed the outstanding balance of the original debt, and the
replacement debt is secured by the property, then the gross value of the property
shall be reduced by the replacement debt. Obligations to related persons
shall not be taken into account for purposes of this paragraph (o)(2)(iii)
unless such obligations constitute interests solely as a creditor pursuant to
the provisions of paragraph (d)(4) of this section and unless the related
person has made similar loans to unrelated persons on similar terms and
conditions.
(iv) Anti-abuse rule. The gross value of real
property located outside the United States and of assets used or held for use
in a trade or business shall be reduced by the outstanding balance of any debt
that was entered into for the principal purpose of avoiding the provisions of
section 897, 1445, or 6039C by enabling the corporation to acquire such
assets. The existence of such a purpose shall be determined with
reference to all the facts and circumstances. Debts that a particular
corporation routinely enters into in the ordinary course of its acquisition of
assets used or held for use in its trade or business will not be considered to
be entered into for the principal purpose of avoiding the provisions of section
897, 1445, or 6039C.
(3) Fair market value of leases and options. For
purposes of sections 897, 1445, and 6039C, the fair market value of a leasehold
interest in real property is the price at which the lease could be assigned or
the property sublet, neither party to such transaction being under any
compulsion to enter into the transaction and both having reasonable knowledge
of all relevant facts. Thus, the value of a leasehold interest will
generally consist of the present value, over the period of the lease remaining,
of the difference between the rental provided for in the lease and the current
rental value of the real property. A leasehold interest bearing restrictions
on its assignment or sublease has a fair market value of zero, but only if
those restrictions in practical effect preclude (rather than merely condition)
the lessee's ability to transfer, at a gain, the benefits of a favorable
lease. The normal commercial practice of lessors may be used to determine
whether restrictions in a lease have the practical effect of precluding
transfer at a gain. The fair market value of an option to purchase any
property is, similarly, the price at which the option could be sold, consisting
generally of the difference between the option price and the fair market value
of the property, taking proper account of any restrictions upon the transfer of
the option.
(4) Fair market value of intangible assets. For
purposes of determining whether a corporation is a U.S. real property holding
corporation, the fair market value of intangible assets described in §
1.897-1(f)(1)(ii) may be determined in accordance with the following rules.
(i) Purchase price. Intangible assets described
in § 1.897-1(f)(1)(ii) that were acquired by purchase from a person not related
to the purchaser within the meaning of § 1.897-1(i) may be valued at their
purchase price. However, such purchase price must be adjusted to reflect
any amortization required by generally accepted accounting principles applied
in the United States. Intangible assets acquired by purchase shall include any
amounts allocated to goodwill or going concern valued pursuant to section
338(b)(3) and regulations thereunder. Intangible assets acquired by
purchase shall not include assets that were acquired indirectly through an
acquisition of stock to which section 338 does not apply. Such assets
must be valued pursuant to a method described in subdivision (ii) or (iii) of
this paragraph (o)(4).
(ii) Book value. Intangible assets described in
§ 1.897-1(f)(1)(ii) (other than good will and going concern value) may be
valued at the amount at which such assets are carried on the financial
accounting records of the holder of such assets, provided that such amount is
determined in accordance with generally accepted accounting principles applied
in the United States. However, this method may not be used with respect to
assets acquired by purchase from a related person within the meaning of §
1.897-1(i).
(iii) Other methods. Intangible assets described
in § 1.897-1(f)(1)(ii) may be valued pursuant to any other reasonable method at
an amount reflecting the price at which the asset would change hands between an
unrelated willing buyer and willing seller, neither being under any compulsion
to buy or to sell and both having reasonable knowledge of all relevant
facts. However, a corporation that uses a method of valuation other than
the purchase price or book value methods may be required to comply with the
special notification requirements of § 1.897-2(h)(1)(iii)(A).
(p) Identifying number. The "identifying
number" of an individual is the individual's United States social security
number. The "identifying number" of any other person is its
United States employer identification number.
Approved by the Office of Management and Budget under control number
1545-0123.